How awful is the comments section of the NY Times? I didn’t see a single coherent response to the article. It’s amazing that people can be so convinced that they understand the underlying causes of the financial crisis without any macro knowledge. Hopefully, advancing the cause of understanding the underlying causes of the financial crisis is not fought in the comments section of that newspaper.

From the NY Times article: “We could have had a decline in housing without a Great Recession.” – NOT TRUE. It’s impossible to claim this, no facts support this assertion.

In fact, a decline in housing of about $7 Trillion USD in 2006 onward was about the same as the decline in stocks in 2000 from the dot.com bubble collapse, and, proportional to the size of the US economy, roughly the same as the oil price shock of 1972 as well as the S&L crisis of the late 1980s, and, as well, the shock to the economy in 1929 from excessive stock and real estate bubbles popping. All of these shocks caused recessions. The making of a “Great Recession” as opposed to an ordinary recession is herd behavior that affects the financial sector, the nerve center of an economy. Fractional reserve banking amplifies an “ordinary” recession into a Great Recession (or Great Depression as in 1930). It’s not Fed interest rates, sticking on the gold standard, nor “tight money”, it’s herd behavior affecting the finance sector.

@RSF – I sort of wish you hadn’t pointed out the comments section. I guess it’s predictable, but now I’m fairly depressed.

As far as I can tell, most of the commenters decided that the article was unpersuasive because (1) it agreed with Ted Cruz on one point; and (2) it didn’t blame the 2008 crash on Republicans.

The depressing thing is that if Sumner, Beckworth, and Ponnuru are right, then there’s a simple and effective policy shift that would improve the economy in these cases. You would think looking for policy innovations like that would be a progressive goal.

We can agree the central bank bungled the job. Its action in late 2008 and 2009 make little sense. However the difficult financial and economic situation experienced in fall 2008 was a consequence of earlier policy failures. I believe the central bank made the situation far worse than it should have been. But even the best monetary response, at that moment, would not have prevented an economic and financial correction.

When speaking of the economy we are talking about a complex, non-linear system that is difficult to measure. There is measurement lag and measurement uncertainty. Given the impossibility to accurately model the economy it is not unreasonable to say that the economy cannot actually be controlled. If you disagree I suggest you talk to some aerodynamic engineers about stability control and the precision, and timeliness of measurement and accuracy of model required to do it.

Your solution to the uncontrollability problem is to claim the answer is in expectations management. This is that if people expect and have confidence the central bank will provide NGDP growth then they will spend and invest and act accordingly. But why should people trust the central bank? You don’t. Even if the Fed adopted NGDPLT it is certain confidence would be tested. The great philosopher Mike Tyson wisely opined “Everyone has a plan until he is punched in the face”. It is certain that no matter the plan or policy embraced by the central bank there will be a punch in the face and many who had confidence in the bank will have their expectations failed.

The most important task of the central bank, if there is such a bank, is to ensure the ROBUSTNESS of the banking system. If the banking system is stressed, or fails as was the argument in fall-2008 (thanks Hank Paulson for your public breakdown on that matter) then the central bank has failed job #1. Enabling the creation of bad credit is a failure in policy and it is only a matter of time before a call on those bad loans will be made. It is foolhardy to ignore years of bad credit decisions and, when failure happens, say that those bad credit decisions did not matter.

Lastly, can anyone provide a description of the dynamics of NGDP stimulus? What would be the response rate? Would it be fast enough? If not then how can one claim that such a policy would smooth economic shocks? Is it not just as possible that monetary injections and retractions under NGDP policy would increase economic instability? Just because you can think of a solution does not mean the solution will actually work when implemented. Non-linear, dynamic systems are not kind to wishful thinking.

Well said, Dan W. I agree with many aspects of market monetarism, but I think it can be pushed too far, and the idea that the Fed could have prevented or even significantly ameliorated the Great Recession by cutting rates a percentage point or two a few months faster in 2008, even if it had somehow possessed perfect foresight about the direction of NGDP expectations, strains credulity. There were very specific problems at the banks that were only loosely tied to broad macroeconomic trends like NGDP expectations. The only thing that could have and eventually did stop the inevitable unfolding of the crisis was the “No More Lehmans” line in the sand. So yes, if the Fed had said in mid-2008, we won’t allow any major bank to fail, that would have had some effect, but cutting rates a couple of points? It might have goosed the markets for a couple of days, but then the panic would have set in again.

Readers note: I supply facts to back up my opinions (the $7T figure, which I researched) while the Sumner minions simply echo opinions sans facts, as their master does. An echo chamber…’excellent blogging’ (not) as Cole will say.

What’s great about the article isn’t that it correctly “blames” the Fed for something that happened 8 years ago, but rather, that it explains what happened by talking about the natural rate of interest. That has importance not just as a historical argument, but pertains to the question of what the Fed should be doing now.

Whether the mainstream media, the general population, and the economics establishment realizes that the Fed can tighten policy without raising rates may very well be the question whose answer either sends the US into or keeps the US out of a recession in 2016.

Your point about 2000 shows that such an asset value decline need not lead to a GR. There was no less of a herd in 07-08 than in 2000. The difference was that the Fed tightened when it should have loosened. After that damage was done, unconventional tools were needed but not ready for action. We had fractional reserve banking on those other occasions, too.

@Dan W.

Yes, when in the middle of a storm, it’s tough to keep the plane flying straight and level. That doesn’t mean it has to crash. For years, people/markets did trust the Greenspan Fed. Even with NGDPLT it would take years to regain that trust, which is not happening in the absence of such a change. The earlier trust developed because of many years of stability, despite nose mashers such as LTCM and the Asian crash. The banking system was certainly over-leveraged and Dodd/Frank didn’t fix that, strangely. But there have been crises with lower leverage, and this one could likely have been milder with better monetary policy.

The dynamics of stimulus is that as the NGDP futures market moves, the Fed pulls levers to get it back on track. That will not be perfect, but level targeting means we can stay on a long term track, despite a bumpy road. The moves the Fed makes will be broadly the ones it makes now, which with exceptions that NGDPLT would have addressed, have been effective.

“S&L crisis of the late 1980s,” & “All of these shocks caused recessions.”

The S&L crisis did not cause a recession – employment and GDP continued to grow throughout the late 80s. Even if you include the 91 recession, that does not necessarily support your argument as it was a relatively mild recession and happened much later than the beginning of the crisis.

How can a Central bank lower rates by 6% in 2.5 years then raise them by 4.5% in 2 years then lower them by 5% in 6 months? Are we really that knowledgeable?

How can people believe the price of oil is an indicator of inflation? There is no correlation between the two. I thought inflation was a monetary phenomenon, not derived from the prices of commodities.

I also do not know how the mechanism works which makes being 6 months too late on dropping rates turn a recession into a great recession.

I also believe the panic on future housing prices was clearly over done. The market was projecting, thru pricing, default rates beyond any level ever seen—-the implied default rates were wrong.

Now was this a function of the tightening?—or did the market grossly misjudge forward default rates. Did the projected defaults not happen because the Fed finally figured it out or are the two phenomena unrelated? Books have been written on this. Nothing persuades me we can know anything with any reasonable degree of certainty.

Having said that, I believe monetary policy should be stable and well defined and actions consistent with goals. It does not seem the current Fed with its Phillips curve beliefs or semi- beliefs is consistent. If 2% inflation is the target, then get 2%—don’t pretend you think it might become 2%.

The journalist who wrote the piece supplied glosses which rendered the economists’ paper tommyrot. Economic recovery began within months of Roosevelt’s inauguration in 1933 and continued for the next 12 years, bar a recession in 1937-38. Real personal disposable income (per capita) was in 1941 24% higher than it had been in 1929 and real personal consumption per capita was 13% higher. These metrics exceeded 1929 values for the 1st time in 1937. It was the labor market which experienced delayed recovery.

“The steep decline this year in the S&P 500 index of shares has fanned concerns among some analysts that the US could be facing an outright recession. Morgan Stanley estimates suggest that the tightening of financial conditions wrought by market moves has been equivalent to four interest rate increases.”

In other words the Fed has already gotten their four rate increases. But they want more blood.

While I’m happy to see MM ideas getting some attention, I’m scared (as our some others I’ve talked to) that this will somehow become a Ted Cruz thing and the ideas won’t be taken seriously. Hopefully I’m wrong. O, and as others have mentioned already and as Scott has discussed previously, the examples that Ray uses support the point that large market downturns do not always lead to significant real output slowdowns.

The NYT comments are about what one expects from porcine contemplation of calcareous concretions. Shrug. They don’t even believe lending standards had anything to do with the housing troubles. This is why countries that pursue seriously leftwing policies run out of toilet paper.

“We could have had a decline in housing without a Great Recession.” That’s the critical nugget. Even if you don’t accept basic economic cause and effect, it should still be obvious that the Fed was too concerned about inflation in 2008.

Dan, The thing that amazes me most about your comment is that there is no engagement with anything I say in this blog. It’s like you’ve never read the blog. And this is after YEARS of commenting.

Larry, I made a similar argument in my book.

E. Harding, Thanks for pointing out the late 1940s. When the GDP data for 2009 was originally reported it was the sharpest drop since the 1930s. But the revised figures for 2009 show the drop was slightly smaller than in 1949.

On the other hand if you use annual data, 2009 was still the worst since the Great Depression.

@Dan W – “The most important task of the central bank, if there is such a bank, is to ensure the ROBUSTNESS of the banking system” – true, nice post, and I would say the fiat fractional reserve banking system is inherently unstable, adopting NGDPLT won’t change that.

@Larry, Joe C: thanks, I acknowledge not every asset drop leads to a Great Recession, but you must acknowledge that an asset drop does lead to a recession (let’s leave aside whether the S&L US 1980s crisis qualifies). And Sumner’s NGDPLT is snake oil.

When a memory leak in software causes servers to crash there is a kernel of truth in saying the problem was not having enough RAM. The causality argument here reminds me of that situation. Operations teams can often find all sorts of kludges to maintain the appearance of order but usually it is best to improve the code.

The obvious response to the NYT commenters going apes*** over a half-sensible op-ed for all the wrong reasons is to publish more similar op-eds without mentioning that Cuban-Canadian-Texan intellectual mediocrity. I guess we have to redpill the mainstream papers on this more. Much more. Publish, publish, publish until it becomes the conventional wisdom. Maybe then their s***-throwing will become more concentrated.

4. Which side are you on? [Here, describe the contradictions of the Left between pretending AD is now the primary problem in the U.S. economy and refusing to blame the Fed for the NGDP collapse of 2008-9].

5. Without passive tightening, what effect would subprime have had?

And protip, get a Berniebro (or sis) or two to help you out as a co-author. Bernie doesn’t have the least sensible monetary policy proposals in the world. By God, the NYT commentators treat AEI and the Koch Brothers like most White Nationalists treat Jews, and for mostly the same reasons.

My questions are:
1) How does the housing collapse compare in size to other sector collapses. We have a sector collapse happening right now in Gas/Oil and other commodities. Oil/gas is a trillion dollar industry in this country, doesn’t it’s current meltdown compare to the housing bubble? Why is the Fed tightening money when this is going on?
2) One of the recurring items that commenters have a hard time with is the idea that the Fed tweaking the overnight interest rate could have such a huge impact on the economy. Personally, looking at the preoccupation of the markets with every Fed statement I believe it. It also scares me because I thing the odds of the Fed getting it right all the time are near zero. So are there structural reasons in the banking industry that make it more susceptible to the vagaries of the Fed that need to be looked at.

The NY Times article argues the natural rate of interest goes down when the economy “weakens”. 1) If interest rate goes down naturally why should rates be controlled centrally as opposed to fluctuating freely? 2) Don’t nominal interest rates increase when the economy declines? Doesn’t that negate the idea that the natural interest rate was actually lower in late 2007/2008?

You mean the fellow Alan Dershowitz described as ‘off the charts brilliant’? Years ago, The American Scholar published a stupid article diagnosing J. Robert Oppenheimer. His problem, per this author, was that he was not ‘brilliant’ like Paul Dirac, but ‘merely very good’.

Scott how sharp the serpent’s tooth. Yes I have read and enjoyed your blog for years. Yes I find it interesting. But I still have some reservations. Perhaps I am clueless. Perhaps, hopefully, I will deepen my understanding when you write a textbook where I can step by step work through the problems. I bought your Midas book and hope to have a block of time to read it soon.

Till then this is the core of my reservations. You and I both, I think, view markets as efficient and rational. Events occur, new information is gained, markets adjust resources. If the Fed supplies sufficient lubrication the reallocation of resources is a much smoother process. If the Fed fails to provide proper lubrication the gears of change start to grind and, worst case, break down. I think we both see the Fed as critical in aiding the reallocation of resources on a daily basis and it’s critical role when shocks hit the system.

We seem to disagree on how quickly the reallocation of resources can occur even if the Fed policy is approaching optimal. I look back at 2007-8 and see a collection of things going bad in the economy. Small oil shock (fall in dollar), auto industry is a sick old man, housing is stressed, “innovations” in the financial industry were not working as expected, uncertainty about government policy (bailouts), you had a relatively unknown Presidential candidate gaining traction, Pelosi elected Speaker, toward the end you had worries about sovereign debt around the world. etc.

I doubt that markets could have responded to all these changes as quickly as your view implies. Housing, Autos, and Financials all had deep problems. The speed with which resources could be reallocated were, I think, limited by the size of these problems and the regulatory policies that influence them. Government policy is heavily involved in all these industries. Housing and Auto manufacturing by there nature are geographically bound. Perhaps it is my bias, but I think even if the Fed had followed your preferred policies regulatory and fiscal policy combined with structural problems in the industries were likely to cause a downturn in the economy

I must admit that I also hold a bias toward rule based monetary policy.

Of course, there was a major oil shock in 2008, just as there would be a smaller one in 2011 (so similar to the 1970s shocks).

From a oil perspective, China became a price maker and the US a price taker after summer 2008. That’s a very big change. And we can see the effects today: China devalues the yuan by a smidgen and the DOW sheds 1,000 points and oil drops $10. We’ve had a change of leadership in the markets, and there’s good intuitive reason to think this might have been a traumatic event.

Scott, I am pretty sure that the above is demonstrably false, using the same futures contracts on fed funds rates that you recently used in a post to make a point.

But before I go look it up, I would like you to agree on the terms: If the futures markets show, say, that the “expected” fed funds rate as of late November 2008 went down after the Fed meetings in late spring and summer, would you agree that the above is a false statement?

(Note that doesn’t mean you have to throw in the towel on the MM explanation, I’m just saying, would you agree that the sentence quoted above is false, if the prices in the futures markets reflect what I’m pretty sure they will show?)

Just to avoid confusion, Scott, in this post you look at futures contracts to see what “the market” thinks the fed funds rate will be at future points in time.

So I’m asking you, what if we go back and look at what these contracts said about the fed funds rate would be, in late November 2008. We first check the implied prediction before various Fed meetings in spring and summer of 2008. Then we check after the Fed meetings. I am pretty sure we will see that after the meetings when the Fed announced tighter policy–according to you and David–the expected fed funds rate for late November 2008 actually went down.

Do you agree that if that turns out to be true, that it is false to say the market expected tighter policy as 2008 progressed, because of the Fed’s statements on inflation worries?

“1) If interest rate goes down naturally why should rates be controlled centrally as opposed to fluctuating freely? 2) Don’t nominal interest rates increase when the economy declines? Doesn’t that negate the idea that the natural interest rate was actually lower in late 2007/2008?”

I don’t believe that interest rates are “controlled centrally”, nor should they be. The Fed does target short term interest rates (probably a bad idea) but that’s not “controlling” them in the sense of overriding market forces.

Nominal rates usually decline when the economy declines, but not always.

Dan, Before you criticize my views you need to understand them. What happened to the unemployment rate between January 2006 and April 2008? Why did that happen? Be specific.

Is there a way to connect what Ray and Scott said? Because I always saw the theory of monetarism as a combination of what Ray and Scott said:

1. Let’s say there’s a huge drop in asset prices. (For whatever reason. The reason itself is not that important).

2. The drop in asset prices means a similar (huge) sudden rise in the value of money.

3. This means a sudden preference for money.

4. Wages need to drop but they don’t drop because there’s the money illusion. Or in other words: Prices are sticky. And it’s not only wages. Pretty much the whole system does not adjust to the new sudden situation fast enough because of money illusions.

5. You print quite some money so as a result the adjustment goes way faster. You can call this hot potato effect if you want to.

See my follow-up post Scott links to above. In it I show the 1-year ahead fed fund futures rate, the market expectation of where the federal funds will be going over the next 12 months. Between late-April il and mid-October is consistently above the actual fed funds rate. Since it is higher that means the fed fund rate was expected to go higher than the existing value of 2%.

More importantly, though, the natural rate is quickly falling over this period as the economy weakens. So the market is expecting rates to go up while the natural rate is going down. That is called a tightening of monetary policy.

@Christian List: “Is there a way to connect what Ray and Scott said? Because I always saw the theory of monetarism as a combination of what Ray and Scott said” I hope not, as I’m doing something wrong if I agree with Sumner.

I think your confusion is that I am talking about a drop in asset prices in a sector, while Sumner is talking about the entire economy’s price level. NGDP affects all industries, not just sectors. My approach is closer to an Austrian economics theory that an economy is really just a collection of largely separate sectors, that cannot easily be summed to get an “NGDP”. This is because it’s not easy to change investments quickly. Hence, an oversupply of houses (or a huge rise in the price of houses) will cause an imbalance in the economy that will require an adjustment (recession) later. I think Sumner is talking about all sectors of the economy, not just one sector.

Put another way: if investments had no hysteresis and were completely interchangeable and fungible, then there really should not be any recession ever, since everything would adjust instantaneously. But in a real economy you cannot reshuffle the deck so easily.

Increasing unemployment means that labor markets will not clear at current wages. You will have downward pressure on wages until the market clears. Unless something prevents the adjustment process.

The Fed can attempt an increase in inflation which will raise nominal wages and fool some of the people to accept lower real wages.

Nevada with a high union labor force saw big increases in unemployment. Michigan with structural problems in the auto industry and years of failed efforts to increase human capital saw large increases in unemployment. Southern states saw cyclical downturns in tourism. California had a variety of problems but was also hit hard by a housing market collapse that was cyclical but possibly a long cycle.

A record number of adjustable rate mortgages were resetting just as the Fed raised rates. The combination of higher oil prices and higher housing costs reduced disposal income for a not insignificant percentage of the population.

Normally the higher housing cost might just go from one pocket to another pocket of the market. But it increased the risk of defaults and lowered the value of the portfolios of financial institutions. The financial institutions became more risk averse and withdrew liquidity from the economy. Interest rates became less an indicator of demand as rationing of credit increased due to uncertainty about pricing and hedging risk. Government response increased uncertainty.

Downward pressure on prices and profits encouraged firms to find lower costs. Once upon a time firms moved from the industrial NE to the South. Now they can seek lower labor costs in Asia or South America. Once historical ties are broken with a region, and under pressure to lower costs, firms feel free to outsource. Biggest losers are communities with unskilled labor. Regulatory and fiscal policy can encourage this outflow. Some blighted areas are just unable to attract investment especially given international alternatives.

As an aside if I was a young academic, I would wonder about the impact of higher minimum wages on violence in urban areas. I.E. Higher minimum wages decrease employment for unskilled youth workers. They enter the underground economy in increasing numbers. Increased competition in the underground economy leads to increased violence. Hope not but not sure.

I don’t doubt that Scott is right that Fed policy could have made the downturn less severe. I just question the magnitude of the impact given everything that was going on and the political environment that it occurred in. Uncertainty about the future would not have been resolved by Fed actions alone. Domestic issues that encouraged the movement of jobs overseas would not have stopped. Regulatory issues would not have cleared up. The need to adjust resources as a result of shocks to the economy would not occur painlessly overnight. Fiscal and regulatory policy slowed the recovery.

I think Scott makes a strong case for what the Fed should have done. I just don’t view it as a silver bullet.

I would argue that some of the volatility in the stock market recently is because of the uncertainty and potential results of the current Presidential race. Some of these candidates must scare you.

I fully admit that I am an economic dilettante. My last Macro courses were long ago. I must admit that I didn’t care for them at the time. Keynes was a waste. I’m sorry that I seem to so irk Scott. Not sure if he is thin skinned or he considers me a fool he should not suffer. Whatever

I would recognize Ray as thoroughly wrong on most everything he says, and his serious delusions, but I strongly doubt he’s a moron. He displays more sophistication than that (though not much; e.g., his claim my Krugman quotes were fake). He said something correct about economics once, but I can’t remember when.

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About

Welcome to a new blog on the endlessly perplexing problem of monetary policy. You’ll quickly notice that I am not a natural blogger, yet I feel compelled by recent events to give it a shot. Read more...

Bio

My name is Scott Sumner and I have taught economics at Bentley University for the past 27 years. I earned a BA in economics at Wisconsin and a PhD at Chicago. My research has been in the field of monetary economics, particularly the role of the gold standard in the Great Depression. I had just begun research on the relationship between cultural values and neoliberal reforms, when I got pulled back into monetary economics by the current crisis.